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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the quarterly period ended March 31, 2003
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from _______ to _________
Commission file number: 0-22635
-------------
RC2 Corporation
------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 36-4088307
-------- ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
800 Veterans Parkway, Bolingbrook, Illinois, 60440-4816
-------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 630-633-3000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
--- ---
On May 12, 2003, there were outstanding 17,142,804 shares of the Registrant's
$0.01 par value common stock.
RC2 CORPORATION
FORM 10-Q
MARCH 31, 2003
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Condensed Consolidated Balance Sheets as of
March 31, 2003 and December 31, 2002 . . . . . . . . . 3
Condensed Consolidated Statements of Earnings
for the Three Months Ended March 31, 2003 and 2002. . . . . 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2003 and 2002. . . . . . . . . 5
Notes to Unaudited Condensed Consolidated
Financial Statements . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk . 18
Item 4. Controls and Procedures. . . . . . . . . . . . . . . . . . 18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . 19
Item 2. Changes in Securities and Use of Proceeds. . . . . . . 19
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . 19
Item 4. Submission of Matters to a Vote of Security Holders. . . . . 19
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . 19
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 20
Signatures and Certifications. . . . . . . . . . . . . . . 21
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RC2 CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, 2003 December 31, 2002
--------------- -----------------
(Unaudited) (Unaudited)
ASSETS:
Current assets:
Cash and cash equivalents. . . . . . . . . $ 20,410 $ 17,104
Restricted cash. . . . . . . . . . . . . . 440 -
Accounts receivable, net . . . . . . . . . 41,557 30,911
Inventory. . . . . . . . . . . . . . . . . 44,505 23,563
Other current assets . . . . . . . . . . . 18,081 11,834
--------- ---------
Total current assets. . . . . . . . . . 124,993 83,412
Property and equipment, net. . . . . . . . 40,640 33,371
Goodwill . . . . . . . . . . . . . . . . . 201,528 119,222
Other non-current assets . . . . . . . . . 8,706 282
--------- ---------
Total assets. . . . . . . . . . . . . . $ 375,867 $ 236,287
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable and accrued expenses. . . $ 43,655 $ 33,132
Current maturities of term loan. . . . . . 13,750 -
Other current liabilities. . . . . . . . . 1,570 741
--------- ---------
Total current liabilities . . . . . . . 58,975 33,873
Revolving line of credit. . . . . . . . . 50,000 8,000
Non current portion of term loan . . . . . 51,250 -
Other long-term liabilities. . . . . . . . 34,134 23,534
--------- ---------
Total liabilities. . . . . . . . . . . 194,359 65,407
Stockholders' equity. . . . . . . . . . . 181,508 170,880
--------- ---------
Total liabilities and stockholders' equity $ 375,867 $ 236,287
========= =========
See accompanying notes to condensed consolidated financial statements.
3
RC2 CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the three months ended
March 31,
--------------------------
2003 2002
----------- -----------
(Unaudited) (Unaudited)
Net sales . . . . . . . . . . . . . . . . . . $42,352 $41,086
Cost of sales . . . . . . . . . . . . . . . . 19,802 20,479
-------- --------
Gross profit . . . . . . . . . . . . . . . . 22,550 20,607
Selling, general and administrative expenses. 17,641 15,575
-------- --------
Operating income. . . . . . . . . . . . . . . 4,909 5,032
Interest expense. . . . . . . . . . . . . . . 360 645
Other income. . . . . . . . . . . . . . . . . (140) (360)
-------- --------
Income before income taxes. . . . . . . . . . 4,689 4,747
Income tax expense. . . . . . . . . . . . . . 1,782 1,899
-------- --------
Net income. . . . . . . . . . . . . . . . . . $ 2,907 $ 2,848
======== ========
Net income per share:
Basic. . . . . . . . . . . . . . . . . . . . $ 0.17 $ 0.19
======== ========
Diluted. . . . . . . . . . . . . . . . . . . $ 0.17 $ 0.18
======== ========
Weighted average shares outstanding:
Basic. . . . . . . . . . . . . . . . . . . . 16,666 14,625
Diluted. . . . . . . . . . . . . . . . . . . 17,551 15,700
See accompanying notes to condensed consolidated financial statements.
4
RC2 CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
For the three months ended
March 31,
--------------------------
2003 2002
----------- -----------
(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 2,907 $ 2,848
Depreciation and amortization. . . . . . . . . . . . . 2,589 2,253
Amortization of deferred financing costs . . . . . . . 25 140
Gain on sale of assets . . . . . . . . . . . . . . . . - (367)
Changes in operating assets and liabilities,
net of LCI acquisition. . . . . . . . . . . . . . . . (6,065) 2,324
------------ ------------
Net cash provided by (used in) operating activities. (544) 7,198
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment . . . . . . . . . . (3,290) (4,416)
Purchase of LCI, net of cash acquired. . . . . . . . . (99,246) -
Proceeds from disposal of property and equipment . . . - 467
Increase in other non-current assets . . . . . . . . . (130) (47)
------------ ------------
Net cash used in investing activities. . . . . . . . (102,666) (3,996)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bank. . . . . . . . . . . . . . . . . . 115,000 -
Payments to bank . . . . . . . . . . . . . . . . . . . (8,000) (4,000)
Issuance of common stock . . . . . . . . . . . . . . . 126 75
------------ ------------
Net cash provided by (used in) financing activities. 107,126 (3,925)
Effect of exchange rates on cash . . . . . . . . . . (170) (157)
------------ ------------
Net increase (decrease) in cash and cash equivalents 3,746 (880)
------------ ------------
Cash and cash equivalents, beginning of period. . . . . 17,104 16,510
Restricted cash . . . . . . . . . . . . . . . . . . . . (440) -
------------ ------------
Cash and cash equivalents, end of period. . . . . . . . $ 20,410 $ 15,630
============ ============
Supplemental information:
Cash flows during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . $ 263 $ 818
Income taxes . . . . . . . . . . . . . . . . . . . . . $ 1,741 $ 3,405
Income tax refunds received. . . . . . . . . . . . . . $ 78 $ 80
Non cash investing and financing activity during
the period:
666,666 shares of common stock issued for the
purchase of LCI. . . . . . . . . . . . . . . . . . . $ 7,810 -
See accompanying notes to condensed consolidated financial statements.
5
RC2 CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of RC2
Corporation and its subsidiaries ("the Company"). All intercompany transactions
and balances have been eliminated.
The accompanying condensed consolidated financial statements have been prepared
by management and, in the opinion of management, contain all adjustments,
consisting of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of March 31, 2003 and the results of
operations and the cash flows for the three-month periods ended March 31, 2003
and 2002.
Certain information and note disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted. It is suggested that these
consolidated financial statements be read in conjunction with the consolidated
financial statements and related notes included in the Company's Form 10-K for
the year ended December 31, 2002.
The results of operations for the three-month period ended March 31, 2003 are
not necessarily indicative of the operating results for the full year.
NOTE 2 - BUSINESS COMBINATION
On March 4, 2003, with an effective date of February 28, 2003, the Company
acquired Learning Curve International, Inc. (Learning Curve) and certain of its
affiliates (collectively, LCI) through the merger of a wholly owned subsidiary
of the Company with and into Learning Curve for approximately $104.4 million in
cash (excluding transaction expenses) and 666,666 shares of the Company's common
stock. The total consideration to be received by the Learning Curve shareholders
in the acquisition will depend on the results of the LCI product lines in 2003.
Additional consideration of up to $6.5 million is contingent upon LCI product
lines achieving certain sales and margin targets. LCI develops and markets a
variety of high-quality, award winning traditional children's toys for every
stage of childhood from birth through age eight. This transaction has been
accounted for under the purchase method of accounting and, accordingly, the
operating results of LCI have been included in the Company's condensed
consolidated financial statements since the effective date of the acquisition.
The purchase was funded with the company's new credit facility (Note 7). The
excess of the aggregate purchase price over the fair market value of net assets
acquired of approximately $83.0 million has been recorded as goodwill in the
accompanying condensed consolidated balance sheet.
The purchase price has been allocated to the acquired assets and assumed
liabilities based on their estimated relative fair values as of the closing of
the LCI acquisition. The purchase price was allocated to the net assets of LCI
based on their estimated relative fair values on February 28, 2003, as follows
(in thousands):
6
Total purchase price, including expenses. . . . . $116,910
--------
Less:
Current assets. . . . . . . . . . . . . . . . . . $ 49,120
Property, plant and equipment, net. . . . . . . . 6,485
Other long-term assets. . . . . . . . . . . . . . 8,511
Liabilities assumed . . . . . . . . . . . . . . . (30,157) 33,959
--------- --------
Excess of purchase price over net assets acquired $ 82,951
========
The allocation of purchase price is subject to final determination based on
valuations and other determinations that will be completed during 2003 including
performing valuations to determine the fair value of any acquired identifiable
intangible assets. To the extent such assets are amortizable, amortization
expense will be increased.
The following unaudited pro forma consolidated financial data for the three
months ended March 31, 2003 and 2002 assume that the LCI acquisition occurred as
of January 1 of each year (in thousands, except per share data):
For the three months ended
March 31,
--------------------------
2003 2002
----------- -----------
(Unaudited) (Unaudited)
Net sales . . . . . . $ 58,879 $ 63,425
----------- -----------
Net income. . . . . . $ 155 $ 1,949
=========== ===========
Net income per share:
Basic . . . . . . . $ 0.01 $ 0.13
=========== ===========
Diluted . . . . . . $ 0.01 $ 0.12
=========== ===========
7
Pro forma data does not purport to be indicative of the results that would have
been obtained had this acquisition actually occurred at the beginning of the
periods presented and is not intended to be a projection of future results.
NOTE 3 - ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation arrangements with employees in
accordance with the provisions of Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and complies with the disclosure
provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation." Under APB No. 25, compensation
expense is recorded based on the difference, if any, on the measurement date,
between the estimated fair value of the Company's stock and the exercise price
of options to purchase that stock. The compensation expense is amortized on a
straight-line basis over the vesting period of the options. To date, no
compensation expense has been recorded related to stock-based compensation
agreements with employees.
Had compensation costs for stock options issued, including options issued for
shares under the employee stock purchase plan, been determined based on the fair
value at their grant date consistent with SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the following pro forma
amounts (in thousands, except per share data):
For the three months ended
March 31,
--------------------------
2003 2002
----------- -----------
(Unaudited) (Unaudited)
Net income as reported.. . . . . . . . . . . . . . . $ 2,907 $ 2,848
Deduct: total stock-based employee compensation
expense determined under fair value based method
for all issuances, net of related tax effects. . . (210) (199)
-------- --------
Pro forma net income . . . . . . . . . . . . . . . . $ 2,697 $ 2,649
======== ========
Basic net income per share
As reported. . . . . . . . . . . . . . . . . . . . $ 0.17 $ 0.19
Pro forma. . . . . . . . . . . . . . . . . . . . . $ 0.16 $ 0.18
Diluted net income per share
As reported. . . . . . . . . . . . . . . . . . . . $ 0.17 $ 0.18
Pro forma. . . . . . . . . . . . . . . . . . . . . $ 0.15 $ 0.17
8
The fair value of each stock option is estimated on the date of grant based on
the Black-Scholes option pricing model assuming, among other things, no dividend
yield, risk-free rates of return from 3.68% to 5.74%, volatility factors of
79.08% to 87.76% and expected life of 5 to 10 years. The weighted average fair
value of options granted during the first quarter of 2003 under the Company's
stock option plan was $11.64. There were no options granted under the Company's
stock option plan during the first quarter of 2002.
The pro forma disclosure is not likely to be indicative of pro forma results
that may be expected in future years because of the fact that options vest over
several years. Compensation expense is recognized as the options vest and
additional awards may be granted.
The Company accounts for stock-based compensation arrangements with
non-employees in accordance with SFAS No. 123, which establishes a fair value
based method of accounting for stock-based compensation plans. Under the fair
value based method, compensation cost is measured at the grant date based on the
value of the award, which is calculated using an option pricing model, and is
recognized over the service period, which is usually the vesting period.
NOTE 4 - BUSINESS SEGMENTS
The Company has no separately reportable segments in accordance with SFAS No.
131, "Disclosure About Segments of an Enterprise and Related Information." Under
the enterprise wide disclosure requirements of SFAS No. 131, the Company reports
net sales, by each group of product lines and by distribution channel. Amounts
for the quarters ended March 31, 2003 and 2002 are as shown in the table below.
(amounts in thousands) 2003 2002
------ ------
Automotive, high performance and
racing vehicle replicas . . . . . . . . . . . . . . . $14,546 $18,783
Traditional children's toys . . . . . . . . . . . . . 11,188 5,548
Agricultural, construction and outdoor
sports vehicle replicas . . . . . . . . . . . . . . . 8,118 8,652
Sports trading cards and racing apparel and souvenirs. 6,359 6,555
Collectible figures. . . . . . . . . . . . . . . . . . 1,700 1,172
Other. . . . . . . . . . . . . . . . . . . . . . . . . 441 376
------- -------
Net sales. . . . . . . . . . . . . . . . . . . . . . . $42,352 $41,086
======= =======
Chain retailers. . . . . . . . . . . . . . . . . . . . $16,459 $14,782
Specialty and hobby wholesalers and retailers. . . . . 14,970 12,859
OEM dealers. . . . . . . . . . . . . . . . . . . . . . 5,205 6,666
Corporate promotional. . . . . . . . . . . . . . . . . 2,792 3,912
Direct to consumer . . . . . . . . . . . . . . . . . . 2,562 2,557
Other. . . . . . . . . . . . . . . . . . . . . . . . . 364 310
------- -------
Net sales. . . . . . . . . . . . . . . . . . . . . . . $42,352 $41,086
======= =======
9
Information for the quarters ended March 31, 2003 and 2002 by geographic area is
set forth in the table below.
(amounts in thousands) 2003 2002
------ ------
Net sales:
United States . . . . . . . . . . . . . $ 37,895 $ 36,717
Foreign . . . . . . . . . . . . . . . . 6,261 4,620
Sales and transfers between geographic
areas. . . . . . . . . . . . . . . . . (1,804) (251)
--------- ---------
Combined total . . . . . . . . . . . . . . . $ 42,352 $ 41,086
========= =========
Operating income:
United States . . . . . . . . . . . . . $ 4,666 $ 4,346
Foreign . . . . . . . . . . . . . . . . 243 686
--------- ---------
Combined total . . . . . . . . . . . . . . . $ 4,909 $ 5,032
========= =========
NOTE 5 - COMPREHENSIVE INCOME
The Company reports comprehensive income in accordance with SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 requires companies to report all
changes in equity during a period, except those resulting from investment by
owners and distributions to owners, in a financial statement for the period in
which they are recognized.
Comprehensive income for the three-month periods ended March 31, 2003 and 2002
is calculated as follows:
10
(amounts in thousands) 2003 2002
------- -------
Net income . . . . . . . . . . . . . . . . . . . . $2,907 $2,848
Other comprehensive loss-foreign
currency translation adjustments. . . . . . . . . (216) (160)
------- -------
Comprehensive income . . . . . . . . . . . . . . . $2,691 $2,688
======= =======
NOTE 6 - COMMON STOCK
Authorized and outstanding shares and the par value of the Company's voting
common stock are as follows:
Shares Shares
outstanding at outstanding at
Authorized shares Par Value March 31, 2003 December 31, 2002
----------------- --------- -------------- -----------------
Voting Common Stock 28,000,000 $ 0.01 17,140,110 16,463,371
At December 31, 2002 the Company held 1,830,295 shares of its common stock in
treasury. In January of 2003 the Company sold 2,823 shares out of treasury to
company employees under the Employee Stock Purchase Plan for $34,681. In March
of 2003 the company sold 6,500 shares out of treasury to three of the Company's
executive officers for $79,677 and issued 750 shares to key employees as part of
compensation for an underlying value of $11,708.
Also, as discussed in Note 2, the Company issued 666,666 shares of the Company's
common stock in connection with its acquisition of LCI.
NOTE 7 - DEBT
Upon the closing of the acquisition of LCI on March 4, 2003, with an effective
date of February 28, 2003, the Company entered into a new credit facility to
replace its April 2002 credit facility (see below). This credit facility is
comprised of a $60.0 million term loan and an $80.0 million revolving loan.
Thirty million dollars of the term loan has an interest rate of 2.61% plus
applicable margin through the maturity of the agreement. The remaining term loan
and revolving loan bear interest, at the Company's option, at a base rate or at
a LIBOR rate plus a margin that varies between 0.75% and 1.75%. The applicable
margin is based on the Company's ratio of consolidated debt to EBITDA (earnings
before interest, taxes, depreciation and amortization). At March 31, 2003, the
margin in effect was 1.75% for LIBOR loans. The Company is also required to pay
a commitment fee of 0.25% to 0.40% per annum on the average daily unused portion
of the revolving loan. Under the terms of this credit facility, the Company is
required to comply with certain financial and non-financial covenants. Among
other restrictions, the Company is restricted in its ability to pay dividends,
incur additional debt and make acquisitions above certain amounts. The key
financial covenants include minimum EBITDA and interest coverage and leverage
ratios. The credit facility is secured by working capital assets and certain
intangible assets. On March 31, 2003, the Company had $115.0 million outstanding
on this credit facility.
11
In April 2002, the Company completed a public offering of 1,545,000 shares of
common stock and certain selling stockholders sold 3,975,000 shares of common
stock at a price of $17.25 per share. The Company received proceeds of $25.2
million from the offering, net of underwriting discount, and used $24.0 million
of the proceeds to repay outstanding debt.
Upon the closing of the public offering, the Company entered into a credit
facility in April 2002 to replace its previous credit facility. The credit
facility was a three-year $50.0 million unsecured revolving loan that bore
interest, at the Company's option, at a base rate or at a LIBOR rate plus a
margin that varied between 0.75% and 1.40%. The applicable margin was based on
the Company's ratio of consolidated debt to consolidated EBITDA. This facility
was replaced with the March 2003 credit facility discussed above.
NOTE 8 - INTEREST RATE COLLAR
The Company's credit agreement prior to April 2002 required that the Company
maintain an interest rate protection agreement. Effective June 3, 1999, the
Company entered into an interest rate collar transaction covering $35 million of
its debt, with a cap based on 30-day LIBOR rates of 8% and floor of 5.09%. The
agreement, which had quarterly settlement dates, was in effect through June 3,
2002. During the first quarter of 2002, the Company paid $266,000 on the
agreement, which was included in interest expense on the accompanying condensed
consolidated statement of earnings.
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." A benefit of approximately $261,000 was recorded in interest
expense on the accompanying condensed consolidated statement of earnings related
to the change in fair value of the interest rate collar during the quarter ended
March 31, 2002.
NOTE 9 - NET INCOME PER SHARE
The Company computes net income per share in accordance with SFAS No. 128,
"Earnings Per Share." Under the provisions of SFAS No. 128, basic net income per
share is computed by dividing the net income for the period by the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed by dividing the net income for the period by the
weighted average number of common and common equivalent shares outstanding
during the period. Certain options and warrants were not included in the
weighted average share calculation as their exercise price exceeded the average
fair market value of the common stock during the period.
12
NOTE 10 - LEGAL PROCEEDINGS
As of December 31, 2002, LCI was a defendant in an action brought by PlayWood
Toys, Inc. alleging that LCI and certain of its officers and employees
misappropriated one or more trade secrets relating to a track manufactured and
sold by LCI as Clickety Clack Track(TM). The case was presented to a jury from
August 4 through August 15, 2000. At the close of PlayWood's case, LCI presented
a motion for judgment, which is the equivalent of a request to dismiss the
claim. The Court deferred ruling on that motion. Following the extended trial,
the jury returned an adverse verdict finding that LCI should pay PlayWood a
substantial royalty on sales of Clickety Clack Track(TM) products for the life
of those products, including royalties for prior LCI sales. LCI then renewed its
motion for judgment, and PlayWood filed its own motion for judgment. On March
13, 2002 the court issued an opinion and order, which found that PlayWood had no
protectable trade secret. Therefore, the court granted LCI's motion for judgment
and denied PlayWood's motion. PlayWood appealed the court's decision, presenting
its case on December 13, 2002. No ruling has been made regarding the appeal. It
has been and remains the opinion of management that this suit was without merit
and that PlayWood's appeal of the Court's order of March 13, 2002 will not be
successful. The Company disputes these claims and intends to vigorously defend
its position although no assurance can be given as to the outcome of this
matter.
The Company has certain contingent liabilities resulting from litigation and
claims incident to the ordinary course of business. Management believes that
the probable resolution of such contingencies will not materially affect the
financial position or the results of the Company's operations.
NOTE 11 - USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
NOTE 12 - RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
NOTE 13 - RELATED PARTY TRANSACTIONS
At March 21, 2003, advances in the amount of $183.3 thousand were due from two
employees and minority interest stockholders of two of the Company's
majority-owned subsidiaries. Interest on these advances is at the prime rate and
the principal portion is due in payments through June 30, 2007.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
The Company leases office and warehouse/distribution space under various
non-cancelable operating lease agreements, which expire through May 15, 2011.
The Company markets virtually all of its products under licenses from other
parties. These licenses are generally limited in scope and duration and
authorize the sale of specific licensed products on a nonexclusive basis. The
Company has approximately 600 licenses with various vehicle and equipment
manufacturers, race team owners, drivers, sponsors, agents and entertainment and
media companies, generally for terms of one to three years. Many of the licenses
include minimum guaranteed royalty payments that the Company must pay whether or
not they meet specified sales targets. The Company believes it either achieved
its minimum guarantees or has accrued for the costs related to these guarantees
for the periods ended March 31, 2003 and 2002.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of the Company's financial condition,
results of operations, liquidity and capital resources. The discussion and
analysis should be read in conjunction with the Company's unaudited condensed
consolidated financial statements and notes thereto included elsewhere herein.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Net sales. Net sales for the first quarter of 2003 increased by 3.2% to $42.4
million compared with $41.1 million for the first quarter of 2002. This sales
increase was primarily attributable to the addition of the LCI business for the
month of March. Net sales increases occurred in our traditional children's toys
and collectible figures categories, but these were partially offset by decreases
in our other product categories.
The increase in net sales in our traditional children's toy category was
approximately 102%, as this is the category that includes all of the LCI product
lines. Net sales in our collectible figures category also increased by
approximately 45%, due primarily to our Joyride Studios figures, which were not
yet available in the first quarter of 2002. Net sales in our automotive, high
performance and racing vehicle replica category decreased approximately 23%,
primarily in racing and model kits. Net sales in our agricultural, construction
and outdoor sports vehicle replicas category decreased approximately 6%;
however, part of this decrease was due to our movement of a collector release
that historically occurs in March to April. Net sales in our sports trading
cards and racing apparel and souvenirs category decreased approximately 3%.
Net sales excluding the results of LCI, decreased by $5.9 million versus the
prior year first quarter. While there were offsetting increases and decreases
for various products in each of our categories, the overall decrease was
primarily due to lower net sales of racing vehicle replicas which were lower by
approximately $3.3 million and model kits which were lower by approximately $2.5
million.
Gross profit. Gross profit increased $2.0 million, or 9.7 %, to $22.6 million
for the three months ended March 31, 2003 from $20.6 million for the three
months ended March 31, 2002. The gross profit margin (as a percentage of net
sales) increased to 53.3 % in the first quarter of 2003 compared to 50.1 % in
the first quarter of 2002 primarily due to favorable product sales mix. There
were no major changes in the components of cost of sales.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $2.0 million, or 12.8%, to $17.6 million for
the three months ended March 31, 2003 from $15.6 million for the three months
ended March 31, 2002. As a percentage of net sales, selling, general and
administrative expenses increased to 41.5 % for the three months ended March 31,
2003 from 37.9% for the three months ended March 31, 2002. The increase in
selling, general and administrative expenses was primarily due to the addition
of the LCI business for the month of March.
Operating income. Operating income decreased slightly to $4.9 million from $5.0
million, and as a percentage of net sales, also decreased slightly to 11.6% of
net sales from 12.2% in the prior year first quarter.
14
Net interest expense. Net interest expense of $0.4 million for the three months
ended March 31, 2003 and $0.6 million for the three months ended March 31, 2002
relates primarily to bank term loans and lines of credit. The decrease in net
interest expense was due to the reduction in average outstanding debt balances
and the decrease in interest rates. Additionally, a benefit of approximately
$261,000 was recorded in net interest expense related to the change in fair
value of the Company's interest rate collar during the first quarter of 2002,
and the Company paid $266,000 on the agreement, which was also included in
interest expense on the accompanying condensed consolidated statements of
earnings. The $115.0 million in debt that the Company incurred in the first
quarter of 2003 will increase interest expense in future periods.
Income tax. Income tax expense for the three months ended March 31, 2003 and
2002 includes provisions for federal, state and foreign income taxes at an
effective rate of 38.0% and 40.0%, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations used net cash of approximately $0.5 million during the
three months ended March 31, 2003. Capital expenditures for the three months
ended March 31, 2003 were approximately $ 3.3 million, of which approximately
$2.8 million was for molds and tooling.
Upon closing of the acquisition of LCI on March 4, 2003, with an effective date
of February 28, 2003, the Company entered into a new credit facility to replace
its April 2002 credit facility (see below). This credit facility is comprised of
a $60.0 million term loan and an $80.0 million revolving loan. Thirty million
dollars of the term loan has an interest rate of 2.61% plus applicable margin
through the maturity of the agreement. The remaining term loan and revolving
loan bear interest, at the Company's option, at a base rate or at a LIBOR rate
plus a margin that varies between 0.75% and 1.75%. The applicable margin is
based on the Company's ratio of consolidated debt to EBITDA. At March 31, 2003,
the margin in effect was 1.75% for LIBOR loans. The Company is also required to
pay a commitment fee of 0.25% to 0.40% per annum on the average daily unused
portion of the revolving loan. Under the terms of this credit facility, the
Company is required to comply with certain financial and non-financial
covenants. Among other restrictions, the Company is restricted in its ability to
pay dividends, incur additional debt and make acquisitions above certain
amounts. The key financial covenants include minimum EBITDA and interest
coverage and leverage ratios. The credit facility is secured by working capital
assets and certain intangible assets. On March 31, 2003, the Company had $115.0
million outstanding on this credit facility and the Company was in compliance
with all covenants.
In April 2002, the Company completed a public offering of 1,545,000 shares of
common stock and certain selling stockholders sold 3,975,000 shares of common
stock at a price of $17.25 per share. The Company received proceeds of $25.2
million from the offering, net of underwriting discount, and used $24.0 million
of the proceeds to repay outstanding debt.
Upon the closing of the public offering, the Company entered into a new credit
facility to replace its previous credit facility. The credit facility was a
three-year $50.0 million unsecured revolving loan that bore interest, at the
Company's option, at a base rate or at a LIBOR rate plus a margin that varied
between 0.75% and 1.40%. The applicable margin was based on the Company's ratio
of consolidated debt to consolidated EBITDA. This credit facility was replaced
with the March 2003 credit facility discussed above.
15
The Company has met its working capital needs through funds generated from
operations and available borrowings under the credit agreement. The Company's
working capital requirements fluctuate during the year based on the seasonality
related to sales. Due to seasonal increases in demand for the Company's
products, working capital financing requirements are usually highest during the
third and fourth quarters. The Company expects that capital expenditures during
2003, principally for molds and tooling, will be approximately $ 16.0
million.
The Company believes that its cash flow from operations, cash on hand and
borrowings under the credit agreement will be sufficient to meet its working
capital and capital expenditure requirements and provide the Company with
adequate liquidity to meet anticipated operating needs for 2003. However, if
the Company's capital requirements vary materially from those currently planned,
the Company may require additional debt or equity financing. There can be no
assurance that financing, if needed, would be available on terms acceptable to
the Company, if at all.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company makes certain estimates and assumptions that affect the
reported amounts of assets and liabilities and the reported amounts of revenues
and expenses. The accounting policies described below are those the Company
considers critical in preparing its consolidated financial statements. These
policies include significant estimates made by management using information
available at the time the estimates are made. However, as described below,
these estimates could change materially if different information or assumptions
were used.
Allowance for Doubtful Accounts. The allowance for doubtful accounts
represents adjustments to customer trade accounts receivable for amounts deemed
uncollectible. The allowance for doubtful accounts reduces gross trade
receivables to their net realizable value. The Company's allowance is based on
management's assessment of the business environment, customers' financial
condition, historical trends, vendor payment practices, receivable aging and
customer disputes. The Company has purchased credit insurance which covers a
portion of its receivables from major customers. The Company will continue to
proactively review its credit risks and adjust its customer terms to reflect the
current environment.
Inventories. Inventories, net of an allowance for excess quantities and
obsolescence, are stated at lower of cost or market. Inventory allowances are
recorded for damaged, obsolete, excess, and slow-moving inventory. The
Company's management uses estimates to record these allowances based on their
review of inventory by product category, length of time on hand, and order
bookings. Changes in public and consumer preferences and demand for product or
changes in the customer's buying patterns and inventory management could impact
the inventory valuation.
16
Impairment of Long-Lived Assets and Goodwill. Long-Lived assets have been
reviewed for impairment based on Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of". This statement requires that an
impairment loss be recognized whenever the sum of the expected future cash flows
(undiscounted and without interest charges) resulting from the use and ultimate
disposal of an asset is less than the carrying amount of the asset. Goodwill has
been reviewed for impairment based on SFAS No. 142, "Goodwill and Other
Intangible Assets". Under SFAS No. 142, goodwill and intangible assets that
have indefinite useful lives will not be amortized but rather will be tested at
least annually for impairment. The Company's management reviews for indicators
that might suggest an impairment loss could exist. Testing for impairment
requires estimates of expected cash flows to be generated from the use of the
assets. Various uncertainties, including changes in consumer preferences,
deterioration in the political environment or changes in general economic
conditions, could impact the expected cash flows to be generated by an asset or
group of assets.
Income Taxes. The Company records current and deferred income tax
liabilities. In determining the required liability, management considers
certain tax exposures and all available evidence. However, if the available
evidence were to change in the future, an adjustment to the tax-related balances
may be required.
Accrued Allowances. We ordinarily accept returns only for defective
merchandise. In certain instances, where retailers are unable to resell the
quantity of products that they have purchased from us, we may, in accordance
with industry practice, assist retailers in selling excess inventory by offering
credits and other price concessions, which are typically evaluated and issued
annually. Other allowances can also be issued for defective merchandise, volume
programs and co-op advertising. All allowances are accrued for throughout the
year, as sales are recorded. The allowances are based on the terms of the
various programs in effect, however, management also takes into consideration
historical trends and specific customer and product information when making its
estimates.
Accrued Royalties. Royalties are accrued based on the provisions in
licensing agreements for amounts due on net sales during the period as well as
management estimates for additional royalty exposures. Royalties vary by product
category and are generally paid on a quarterly basis. Multiple royalties may be
paid to various licensors on a single product. Royalty expense is included in
selling, general and administrative expenses on the condensed consolidated
statements of earnings.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report contain "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
These statements may be identified by the use of forward-looking words or
phrases such as "anticipate," "believe," "could," "expect," "intend,""may,"
"planned," "potential," "should," "estimate," "predict," "continue," "future,"
"will," "would" or the negative of those terms or other words of similar
meaning. Such forward-looking statements are inherently subject to known and
unknown risks and uncertainties. The Company's actual results and future
developments could differ materially from the results or developments expressed
in, or implied by, these forward-looking statements. Factors that may cause
actual results to differ materially from those contemplated by such
forward-looking statements include, but are not limited to, the following: (1)
the Company may experience difficulty in integrating its acquisition of LCI; (2)
the debt leverage incurred by the Company in connection with the LCI acquisition
could adversely affect the Company's profit margins, limit the Company's ability
17
to capitalize on future business opportunities and subject the Company to
adverse effects from fluctuations in interest rates; (3) the Company may not be
able to manufacture, source and ship new and continuing products on a timely
basis and customers and consumers may not accept those products at prices
sufficient for the Company to profitably recover development, manufacturing,
marketing, royalty and other costs; (4) the Company is dependent on timely
shipping of product and unloading of product through West Coast ports as well as
timely rail/truck delivery to the Company's warehouse and/or customers'
warehouses; (5) the inventory policies of retailers, together with increased
reliance by retailers on quick response inventory management techniques, may
increase the risk of underproduction of popular items, overproduction of less
popular items and failure to achieve tight shipping schedules; (6) competition
in the markets for the Company's products may increase significantly; (7) the
Company is dependent upon continuing licensing arrangements with vehicle
manufacturers, agricultural equipment manufacturers, major race sanctioning
bodies, race team owners, drivers, sponsors, agents and other licensors; (8) the
Company may experience unanticipated negative results of litigation; (9) the
Company relies upon a limited number of independently owned factories located in
China to manufacture a significant portion of its vehicle replicas and certain
other products; (10) the Company is dependent upon the continuing willingness of
leading retailers to purchase and provide shelf space for the Company's
products; (11) the Company may not be able to collect outstanding accounts
receivable from its major retail customers; (12) the Company is subject to risks
related to doing business in foreign markets, including currency exchange rate
fluctuations, economic and political instability, restrictive actions by foreign
governments, and complications in complying with trade and foreign tax laws; and
(13) general economic conditions in the Company's markets. The Company
undertakes no obligation to make any revisions to the forward-looking statements
contained in this report or to update them to reflect events or circumstances
occurring after the date of this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Based on the Company's interest rate exposure on variable borrowing at March 31,
2003, a one-percentage-point increase in average interest rates on the Company's
borrowings would increase future interest expense by approximately $71,000 per
month.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and the Company's
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on this evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective in timely alerting
them to material information relating to the Company required to be included in
the Company's periodic filings with the Securities and Exchange Commission. It
should be noted that in designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date the Company completed its evaluation.
18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company has certain contingent liabilities resulting from litigation and
claims incident to the ordinary course of business. Management believes that
the probable resolution of such contingencies will not materially affect the
financial position or the results of the Company's operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not applicable.
(b) Not applicable.
(c) Effective March 26, 2003, the Company sold 2,500 shares of common
stock to Curtis W. Stoelting, the Company's Chief Executive Officer,
2,500 shares of common stock to Peter J. Henseler, the Company's
President, and 1,500 shares of common stock to Jody L. Taylor, the
Company's Chief Financial Officer and Secretary. The shares were sold
from the Company's treasury stock at a price of $12.26 per share. The
shares were sold in a private placement exempt from the registration
requirements of the Securities Act of 1933, as amended (the
"Securities Act"), pursuant to Section 4(2) of the Securities Act.
Pursuant to the LCI acquisition, the Company issued 525,877 shares of
common stock to Richard E. Rothkopf and 140,789 shares of common stock
to The John W. Lee Revocable Trust. John W. Lee II is the sole trustee
of The John W. Lee Revocable Trust. Mr. Rothkopf is an Executive Vice
President and director of the Company and Chairman of Learning Curve
and Mr. Lee is an Executive Vice President of the Company and
President of Learning Curve. The shares were issued in a private
placement exempt from the registration requirements of the Securities
Act, pursuant to Section 4(2) of the Securities Act.
(d) Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002 (File No. 0-22635) filed by the Company with the Securities
and Exchange Commission on May 14, 2002).
3.2 First Amendment to the Amended and Restated Certificate of
Incorporation of the Company (incorporated by reference to
Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2002 (File No. 0-22635) filed by the
Company with the Securities and Exchange Commission on May 14,
2002).
3.3 Certificate of Ownership and Merger changing the Company's name
to Racing Champions Ertl Corporation (incorporated by reference
to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2002 (File No. 0-22635) filed by the
Company with the Securities and Exchange Commission on May 14,
2002).
3.4 Certificate of Ownership and Merger changing the Company's name
to RC2 Corporation.
3.5 Amended and Restated By-Laws of the Company (incorporated by
reference to Exhibit 3.3 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998 (File No.
0-22635) filed by the Company with the Securities and Exchange
Commission on August 14, 1998).
10.1 Agreement and Plan of Merger, dated as of February 3, 2003, among
the Company, RBVD Sub I Inc., Racing Champions Worldwide Limited,
Racing Champions Limited and Learning Curve International, Inc.
(incorporated by reference to Exhibit 2.1 of the Company's
Current Report on Form 8-K dated March 4, 2003 (File No. 0-22635)
filed by the Company with the Securities and Exchange Commission
on March 18, 2003).
10.2 Credit Agreement, dated as of March 4, 2003, by and among the
Company, RC Ertl, Inc., Racing Champions South, Inc., Learning
Curve International, Inc., Racing Champions Worldwide Limited,
Harris Trust and Savings Bank, as lender and administrative
agent, certain other corporations party thereto and the other
lenders party thereto (incorporated by reference to Exhibit 99.1
of the Company's Current Report on Form 8-K dated March 4, 2003
(File No. 0-22635) filed by the Company with the Securities and
Exchange Commission on March 18, 2003).
(b) Reports on Form 8-K:
Form 8-K dated March 4, 2003, filed with the Securities and Exchange
Commission on March 18, 2003, to report the acquisition of LCI
pursuant to Item 2.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated this 15th day of May 2003.
RC2 CORPORATION
By /s/ Curtis W. Stoelting
___________________________________
Curtis W. Stoelting, Chief
Executive Officer
By /s/ Jody L. Taylor
_________________________________
Jody L. Taylor, Chief Financial
Officer and Secretary
21
CERTIFICATIONS
I, Curtis W. Stoelting, Chief Executive Officer of RC2 Corporation, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of RC2
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
22
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
/s/ Curtis W. Stoelting
---------------------------------
Curtis W. Stoelting
Chief Executive Officer
23
I, Jody L. Taylor, Chief Financial Officer of RC2 Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of RC2
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
24
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
/s/ Jody L. Taylor
---------------------------------
Jody L. Taylor
Chief Financial Officer
25